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FIRST FINANCIAL BANKSHARES INC - Quarter Report: 2013 March (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

Commission file number 0-7674

 

 

FIRST FINANCIAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   75-0944023

(State or other jurisdiction of incorporation

or organization)

 

(I.R.S. Employer

Identification No.)

400 Pine Street, Abilene, Texas   79601
(Address of principal executive offices)   (Zip Code)

(325) 627-7155

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

  

Outstanding at April 26, 2013

Common Stock, $0.01 par value per share

   31,532,851

 

 

 


Table of Contents

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

 

Item

       Page  

1.

  Financial Statements      1   

Consolidated Balance Sheets—Unaudited

     2   

Consolidated Statements of Earnings—Unaudited

     3   

Consolidated Statements of Comprehensive Earnings—Unaudited

     4   

Consolidated Statements of Changes in Shareholders’ Equity—Unaudited

     5   

Consolidated Statements of Cash Flows—Unaudited

     6   

Notes to Consolidated Financial Statements—Unaudited

     7   

2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      25   

3.

  Quantitative and Qualitative Disclosures About Market Risk      38   

4.

  Controls and Procedures      38   
  PART II   
  OTHER INFORMATION   

1.

  Legal Proceedings      40   

1A.

  Risk Factors      40   

2.

  Unregistered Sales of Equity Securities and Use of Proceeds      40   

3.

  Defaults Upon Senior Securities      40   

4.

  Mine Safety Disclosures      40   

5.

  Other Information      40   

6.

  Exhibits      41   
  Signatures      42   


Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

The consolidated balance sheets of First Financial Bankshares, Inc. (the “Company”) at March 31, 2013 and 2012 and December 31, 2012, and the consolidated statements of earnings, comprehensive earnings, changes in shareholders’ equity and cash flows for the three months ended March 31, 2013 and 2012, follow on pages 2 through 6.

 

1


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

 

     March 31,     December 31,  
     2013     2012     2012  
     (Unaudited)        
ASSETS   

CASH AND DUE FROM BANKS

   $ 113,958      $ 131,163      $ 207,018   

FEDERAL FUNDS SOLD

     3,175        11,200        14,045   

INTEREST-BEARING DEPOSITS IN BANKS

     20,065        84,169        139,676   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     137,198        226,532        360,739   

INTEREST-BEARING TIME DEPOSITS IN BANKS

     45,172        62,018        49,005   

SECURITIES AVAILABLE-FOR-SALE, at fair value

     1,958,151        1,960,760        1,819,035   

SECURITIES HELD-TO-MATURITY (fair value of $920, $2,612 and $1,080 at
March 31, 2013 and 2012 and December 31, 2012, respectively)

     903        2,581        1,061   

LOANS

      

Held for investment

     2,128,015        1,793,172        2,077,166   

Less - allowance for loan losses

     (34,672     (34,529     (34,839
  

 

 

   

 

 

   

 

 

 

Net loans held for investment

     2,093,343        1,758,643        2,042,327   

Held for sale

     10,122        5,695        11,457   
  

 

 

   

 

 

   

 

 

 

Net loans

     2,103,465        1,764,338        2,053,784   

BANK PREMISES AND EQUIPMENT, net

     86,265        79,308        84,122   

INTANGIBLE ASSETS

     71,963        72,078        71,973   

OTHER ASSETS

     52,863        59,635        62,293   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 4,455,980      $ 4,227,250      $ 4,502,012   
  

 

 

   

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY       

NONINTEREST-BEARING DEPOSITS

   $ 1,237,840      $ 1,125,577      $ 1,311,708   

INTEREST-BEARING DEPOSITS

     2,312,286        2,272,495        2,320,876   
  

 

 

   

 

 

   

 

 

 

Total deposits

     3,550,126        3,398,072        3,632,584   

DIVIDENDS PAYABLE

     7,879        7,553        —     

SHORT-TERM BORROWINGS

     263,345        237,567        259,697   

OTHER LIABILITIES

     70,378        67,053        52,768   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     3,891,728        3,710,245        3,945,049   
  

 

 

   

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

      

SHAREHOLDERS’ EQUITY

      

Common stock - $0.01 par value, authorized 80,000,000 shares; 31,519,973, 31,477,483, and 31,496,881 shares issued at March 31, 2013 and 2012 and December 31, 2012, respectively

     315        315        315   

Capital surplus

     278,122        276,623        277,412   

Retained earnings

     238,625        195,074        227,927   

Treasury stock (shares at cost: 268,348, 261,454, and 266,845 at March 31, 2013 and 2012 and December 31, 2012, respectively)

     (5,138     (4,712     (5,007

Deferred compensation

     5,138        4,712        5,007   

Accumulated other comprehensive earnings

     47,190        44,993        51,309   
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     564,252        517,005        556,963   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 4,455,980      $ 4,227,250      $ 4,502,012   
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

2


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS—(UNAUDITED)

(Dollars in thousands, except per share amounts)

 

     Three Months Ended March 31,  
         2013             2012      

INTEREST INCOME:

    

Interest and fees on loans

   $ 26,445      $ 24,640   

Interest on investment securities:

    

Taxable

     6,375        8,804   

Exempt from federal income tax

     6,579        6,141   

Interest on federal funds sold and interest-bearing deposits in banks

     176        212   
  

 

 

   

 

 

 

Total interest income

     39,575        39,797   

INTEREST EXPENSE:

    

Interest on deposits

     867        1,482   

Other

     37        58   
  

 

 

   

 

 

 

Total interest expense

     904        1,540   
  

 

 

   

 

 

 

Net interest income

     38,671        38,257   

PROVISION FOR LOAN LOSSES

     401        1,296   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     38,270        36,961   
  

 

 

   

 

 

 

NONINTEREST INCOME:

    

Trust fees

     3,793        3,454   

Service charges on deposit accounts

     3,895        3,882   

ATM, interchange and credit card fees

     3,729        3,676   

Real estate mortgage operations

     1,384        1,050   

Net gain on available-for-sale securities (includes $222 and $346 for the three months ended March 31, 2013 and 2012, respectively, related to accumulated other comprehensive earnings reclassifications)

     222        346   

Net gain (loss) on sale of foreclosed assets

     (316     6   

Other

     1,253        884   
  

 

 

   

 

 

 

Total noninterest income

     13,960        13,298   

NONINTEREST EXPENSE:

    

Salaries and employee benefits

     15,180        14,229   

Net occupancy expense

     1,766        1,737   

Equipment expense

     2,281        2,108   

FDIC insurance premiums

     572        527   

ATM, interchange and credit card expenses

     1,340        1,249   

Professional and service fees

     803        737   

Printing, stationery and supplies

     472        505   

Amortization of intangible assets

     10        44   

Other

     5,047        5,332   
  

 

 

   

 

 

 

Total noninterest expense

     27,471        26,468   
  

 

 

   

 

 

 

EARNINGS BEFORE INCOME TAXES

     24,759        23,791   

INCOME TAX EXPENSE (includes $78 and $121 for the three months ended March 31, 2013 and 2012, respectively, related to income tax expense from reclassification items)

     6,182        6,035   
  

 

 

   

 

 

 

NET EARNINGS

   $ 18,577      $ 17,756   
  

 

 

   

 

 

 

EARNINGS PER SHARE, BASIC

   $ 0.59      $ 0.56   
  

 

 

   

 

 

 

EARNINGS PER SHARE, ASSUMING DILUTION

   $ 0.59      $ 0.56   
  

 

 

   

 

 

 

DIVIDENDS PER SHARE

   $ 0.25      $ 0.24   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS—(UNAUDITED)

(Dollars in thousands)

 

     Three Months Ended March 31,  
         2013             2012      

NET EARNINGS

   $ 18,577      $ 17,756   

OTHER ITEMS OF COMPREHENSIVE EARNINGS:

    

Change in unrealized gain on investment securities available-for-sale, before income taxes

     (6,115     (3,088

Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax

     (222     (346
  

 

 

   

 

 

 

Total other items of comprehensive earnings

     (6,337     (3,434

Income tax expense related to other items of comprehensive earnings

     2,218        1,202   
  

 

 

   

 

 

 

COMPREHENSIVE EARNINGS

   $ 14,458      $ 15,524   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

4


Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share amounts)

 

     Common Stock      Capital
Surplus
     Retained
Earnings
    Treasury Stock     Deferred
Compensation
     Accumulated
Other
Comprehensive

Earnings
    Total
Shareholders’

Equity
 
     Shares      Amount           Shares     Amounts         

Balances at December 31, 2011

     31,459,635       $ 314       $ 276,127       $ 184,871        (258,235   $ (4,597   $ 4,597       $ 47,225      $ 508,537   

Net earnings (unaudited)

     —           —           —           17,756        —          —          —           —          17,756   

Stock issuances (unaudited)

     17,848         1         398         —          —          —          —           —          399   

Cash dividends declared, $0.24 per share (unaudited)

     —           —           —           (7,553     —          —          —           —          (7,553

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —           —           —           —          —          —          —           (2,232     (2,232

Additional tax benefit related to directors’ deferred compensation plan (unaudited)

     —           —           10         —          —          —          —           —          10   

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —           —           —           —          (3,219     (115     115         —          —     

Stock option expense (unaudited)

     —           —           88         —          —          —          —           —          88   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at March 31, 2012 (unaudited)

     31,477,483       $ 315       $ 276,623       $ 195,074        (261,454   $ (4,712   $ 4,712       $ 44,993      $ 517,005   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at December 31, 2012

     31,496,881       $ 315       $ 277,412       $ 227,927        (266,845   $ (5,007   $ 5,007       $ 51,309      $ 556,963   

Net earnings (unaudited)

     —           —           —           18,577        —          —          —           —          18,577   

Stock issuances (unaudited)

     23,092         —           612         —          —          —          —           —          612   

Cash dividends declared, $0.25 per share (unaudited)

     —           —           —           (7,879     —          —          —           —          (7,879

Change in unrealized gain in investment securities available-for-sale, net of related income taxes (unaudited)

     —           —           —           —          —          —          —           (4,119     (4,119

Additional tax benefit related to directors’ deferred compensation plan (unaudited)

     —           —           10         —          —          —          —           —          10   

Shares purchased in connection with directors’ deferred compensation plan, net (unaudited)

     —           —           —           —          (1,503     (131     131         —          —     

Stock option expense (unaudited)

     —           —           88         —          —          —          —           —          88   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances at March 31, 2013 (unaudited)

     31,519,973       $ 315       $ 278,122       $ 238,625        (268,348   $ (5,138   $ 5,138       $ 47,190      $ 564,252   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS—(UNAUDITED)

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2013     2012  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net earnings

   $ 18,577      $ 17,756   

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Depreciation and amortization

     2,007        1,887   

Provision for loan losses

     401        1,296   

Securities premium amortization (discount accretion), net

     4,208        3,610   

Gain on sale of assets, net

     (74     (474

Deferred federal income tax expense (benefit)

     —          (4

Change in loans held for sale

     1,334        4,934   

Change in other assets

     8,732        1,842   

Change in other liabilities

     7,440        5,897   
  

 

 

   

 

 

 

Total adjustments

     24,048        18,988   
  

 

 

   

 

 

 

Net cash provided by operating activities

     42,625        36,744   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease (increase) in interest-bearing time deposits in banks

     3,833        (843

Activity in available-for-sale securities:

    

Sales

     5,227        21,003   

Maturities

     94,803        76,390   

Purchases

     (236,984     (222,889

Activity in held-to-maturity securities—maturities

     158        1,028   

Net increase in loans

     (51,454     (18,162

Purchases of bank premises and equipment and other assets

     (4,567     (5,063

Proceeds from sale of other assets

     1,015        1,555   
  

 

 

   

 

 

 

Net cash used in investing activities

     (187,969     (146,981
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase (decrease) in noninterest-bearing deposits

     (73,868     24,001   

Net increase (decrease) in interest-bearing deposits

     (8,590     39,272   

Net increase in short-term borrowings

     3,648        29,811   

Common stock transactions:

    

Proceeds from stock issuances

     613        399   

Dividends paid

     —          (7,550
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (78,197     85,933   
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (223,541     (24,304

CASH AND CASH EQUIVALENTS, beginning of period

     360,739        250,836   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 137,198      $ 226,532   
  

 

 

   

 

 

 

SUPPLEMENTAL INFORMATION AND NONCASH TRANSACTIONS

    

Interest paid

   $ 953      $ 1,653   

Federal income tax paid

     —          —     

Transfer of loans to foreclosed assets

     39        82   

Investment securities purchased but not settled

     21,095        21,895   

See notes to consolidated financial statements.

 

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Table of Contents

FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1—Basis of Presentation

The interim consolidated financial statements include the accounts of the Company, a Texas corporation and a financial holding company registered under the Bank Holding Company Act of 1956, as amended, or BHCA, and its wholly-owned subsidiaries: First Financial Bank, National Association, Abilene, Texas; First Technology Services, Inc.; First Financial Trust & Asset Management Company, National Association; First Financial Investments, Inc.; and First Financial Insurance Agency, Inc.

Through our subsidiary bank, we conduct full-service commercial banking business. Our banking centers are located primarily in Central, North Central and West Texas. As of March 31, 2013, we had 56 financial centers across Texas, with eleven locations in Abilene, two locations in Cleburne, two locations in Stephenville, two locations in Granbury, three locations in San Angelo, three locations in Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater, Eastland, Ranger, Rising Star, Cisco, Southlake, Grapevine, Aledo, Willow Park, Brock, Alvarado, Burleson, Keller, Trophy Club, Boyd, Bridgeport, Decatur, Roby, Trent, Merkel, Clyde, Moran, Albany, Midlothian, Crowley, Glen Rose, Odessa, Waxahachie, Acton, Fort Worth and Huntsville. Our trust subsidiary has six locations which consist of Abilene, San Angelo, Stephenville, Sweetwater, Fort Worth and Odessa, all in Texas.

In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments necessary for a fair presentation of the Company’s financial position and unaudited results of operations and should be read in conjunction with the Company’s audited consolidated financial statements, and notes thereto in the Company’s Annual Report on Form 10-K, for the year ended December 31, 2012. All adjustments were of a normal recurring nature. However, the results of operations for the three months ended March 31, 2013, are not necessarily indicative of the results to be expected for the year ending December 31, 2013, due to seasonality, changes in economic conditions and loan credit quality, interest rate fluctuations, regulatory and legislative changes and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted under SEC rules and regulations. The Company evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued.

Effective December 30, 2012, the Company consolidated its eleven bank charters into one charter. The Company cited regulatory, compliance and technology complexities and the opportunity for cost savings as its reason for making this change. The Company noted it expects to operate the one charter as it previously did with eleven charters with local management and board decisions to benefit the customers and communities it serves.

On October 26, 2011, the Company’s Board of Directors authorized the repurchase of up to 750,000 common shares through September 30, 2014. The stock buyback plan authorizes management to repurchase the stock at such time as repurchases are considered beneficial to shareholders. Any repurchase of stock will be made through the open market, block trades or in privately negotiated transactions in accordance with applicable laws and regulations. Under the repurchase plan, there is no minimum number of shares that the Company is required to repurchase. Through March 31, 2013, no shares have been repurchased under this authorization.

On April 24, 2012, the Company’s shareholders approved an amendment to the Company’s Amended and Restated Certificate of Formation to increase the number of authorized common shares to 80,000,000.

Goodwill and other intangible assets are evaluated annually for impairment as of the end of the second quarter. No such impairment has been noted in connection with the current or any prior evaluations.

 

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Note 2—Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding during the periods presented. In computing diluted earnings per common share for the three months ended March 31, 2013 and 2012, the Company assumes that all dilutive outstanding options to purchase common stock have been exercised at the beginning of the period (or the time of issuance, if later). The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the respective periods. The weighted average common shares outstanding used in computing basic earnings per common share for the three months ended March 31, 2013 and 2012, were 31,507,975 and 31,466,706 shares, respectively. The weighted average common shares outstanding used in computing fully diluted earnings per common share for the three months ended March 31, 2013 and 2012, were 31,601,364 and 31,479,743 respectively.

Note 3 – Interest-bearing Time Deposits in Banks and Securities

Interest-bearing time deposits in banks totaled $45,172,000 and $49,005,000 at March 31, 2013 and December 31, 2012, respectively, and have original maturities generally ranging from one to two years. Of these amounts, $40,943,000 and $44,776,000 are time deposits with balances greater than $100,000 at March 31, 2013 and December 31, 2012, respectively.

The Company records its available-for-sale and trading securities portfolio at fair value.

Management classifies debt and equity securities as held-to-maturity, available-for-sale, or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Securities not classified as held-to-maturity or trading are classified as available-for-sale and recorded at estimated fair value, with all unrealized gains and unrealized losses judged to be temporary, net of deferred income taxes, excluded from earnings and reported in the consolidated statements of comprehensive earnings. Available-for-sale securities that have unrealized losses that are judged other than temporary are included in gain (loss) on sale of securities and a new cost basis is established. Securities classified as trading are recorded at estimated fair value with unrealized gains and losses included in earnings.

Fair values of these securities are determined based on methodologies in accordance with current authoritative accounting guidance. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.

When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) whether we have the intent to sell our securities prior to recovery and/or maturity, (ii) whether it is more likely than not that we will have to sell our securities prior to recovery and/or maturity, (iii) the length of time and extent to which the fair value has been less than costs, and (iv) the financial condition of the issuer. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

 

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Table of Contents

The Company’s investment portfolio consists of traditional investments, substantially all in U.S. Treasury securities, obligations of U.S. government sponsored-enterprises and agencies, mortgage pass-through securities, corporate bonds and general obligation or revenue based municipal bonds. Pricing for such securities is generally readily available and transparent in the market. The Company utilizes independent third party pricing services to assist in valuing its investment securities. The Company reviews the prices supplied by the independent pricing services as well as the underlying pricing methodologies for reasonableness and to ensure such prices are aligned with traditional pricing matrices. The Company validates quarterly, on a sample basis, prices supplied by the independent pricing services by comparison to prices obtained from other third party sources.

A summary of available-for-sale and held-to-maturity securities follows (in thousands):

 

     March 31, 2013  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

Securities available-for-sale:

          

U.S. Treasury securities

   $ 6,017       $ 23       $ —        $ 6,040   

Obligations of U.S. government sponsored-enterprises and agencies

     189,913         3,451         —          193,364   

Obligations of states and political subdivisions

     865,282         53,191         (558     917,915   

Corporate bonds and other

     111,669         5,553         —          117,222   

Residential mortgage-backed securities

     592,911         23,866         (213     616,564   

Commercial mortgage-backed securities

     106,898         1,408         (1,260     107,046   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 1,872,690       $ 87,492       $ (2,031   $ 1,958,151   
  

 

 

    

 

 

    

 

 

   

 

 

 

Securities held-to-maturity:

          

Obligations of states and political subdivisions

   $ 595       $ 5       $ —        $ 600   

Residential mortgage-backed securities

     308         12         —          320   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total debt securities held-to-maturity

   $ 903       $ 17       $ —        $ 920   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents
     December 31, 2012  
     Amortized
Cost Basis
     Gross
Unrealized
Holding Gains
     Gross
Unrealized
Holding Losses
    Estimated
Fair Value
 

Securities available-for-sale:

          

U.S. Treasury securities

   $ 6,042       $ 48       $ —        $ 6,090   

Obligations of U.S. government sponsored-enterprises and agencies

     219,420         4,060         —          223,480   

Obligations of states and political subdivisions

     786,278         57,541         (129     843,690   

Corporate bonds and other

     117,244         6,020         (73     123,191   

Residential mortgage-backed securities

     564,434         23,285         (443     587,276   

Commercial mortgage-backed securities

     33,819         1,739         (250     35,308   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available-for-sale

   $ 1,727,237       $ 92,693       $ (895   $ 1,819,035   
  

 

 

    

 

 

    

 

 

   

 

 

 

Securities held-to-maturity:

          

Obligations of states and political subdivisions

   $ 735       $ 7       $ —        $ 742   

Residential mortgage-backed securities

     294         11         —          305   

Commercial mortgage-backed securities

     32         1         —          33   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total debt securities held-to-maturity

   $ 1,061       $ 19       $ —        $ 1,080   
  

 

 

    

 

 

    

 

 

   

 

 

 

The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at March 31, 2013, were computed by using scheduled amortization of balances and historical prepayment rates. At March 31, 2013 and December 31, 2012, the Company did not hold any CMOs that entail higher risks than standard mortgage-backed securities.

The amortized cost and estimated fair value of debt securities at March 31, 2013, by contractual and expected maturity, are shown below (in thousands):

 

     Available-for-Sale      Held-to-Maturity  
     Amortized
Cost Basis
     Estimated
Fair Value
     Amortized
Cost Basis
     Estimated
Fair Value
 

Due within one year

   $ 142,205       $ 144,366       $ 595       $ 600   

Due after one year through five years

     509,641         532,461         —           —     

Due after five years through ten years

     495,789         530,064         —           —     

Due after ten years

     25,246         27,650         —           —     

Mortgage-backed securities

     699,809         723,610         308         320   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,872,690       $ 1,958,151       $ 903       $ 920   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following tables disclose, as of March 31, 2013 and December 31, 2012, the Company’s investment securities that have been in a continuous unrealized-loss position for less than 12 months and for 12 months or longer (in thousands):

 

     Less than 12 Months      12 Months or Longer      Total  

March 31, 2013

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of states and political subdivisions

   $ 42,102       $ 558       $ —         $ —         $ 42,102       $ 558   

Residential mortgage-backed securities

     8,664         9         14,885         204         23,549         213   

Commercial mortgage-backed securities

     38,472         1,260         —           —           38,472         1,260   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 89,238       $ 1,827       $ 14,885       $ 204       $ 104,123       $ 2,031   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 Months      12 Months or Longer      Total  

December 31, 2012

   Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
     Fair Value      Unrealized
Loss
 

Obligations of states and political subdivisions

   $ 36,480       $ 129       $ —         $ —         $ 36,480       $ 129   

Residential mortgage-backed securities

     17,344         401         3,574         42         20,918         443   

Commercial mortgage-backed securities

     12,453         250         —           —           12,453         250   

Corporate bonds and other

     4,994         73         —           —           4,994         73   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 71,271       $ 853       $ 3,574       $ 42       $ 74,845       $ 895   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The number of investment positions in an unrealized loss position totaled 108 at March 31, 2013. We do not believe these unrealized losses are “other than temporary” as (i) we do not have the intent to sell our securities prior to recovery and/or maturity and (ii) it is more likely than not that we will not have to sell our securities prior to recovery and/or maturity. In making the determination, we also consider the length of time and extent to which fair value has been less than cost and the financial condition of the issuer. The unrealized losses noted are interest rate related due to the level of interest rates at March 31, 2013 compared to the time of purchase. We have reviewed the ratings of the issuers and have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Our mortgage related securities are backed by GNMA, FNMA and FHLMC or are collateralized by securities backed by these agencies.

Securities, carried at approximately $870,328,000 at March 31, 2013, were pledged as collateral for public or trust fund deposits, repurchase agreements and for other purposes required or permitted by law.

During the quarter ended March 31, 2013 and 2012, sales of investment securities that were classified as available-for-sale totaled $5,227,000 and $21,003,000, respectively. Gross realized gains from securities sales and calls during the first quarter of 2013 and 2012 totaled $223,000 and $346,000, respectively. Gross realized losses from securities sales and calls during the first quarter of 2013 totaled $1,000. There were no losses realized on securities sales and calls during the first quarter of 2012. The specific identification method was used to determine cost in order to compute the realized gains and losses.

 

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Table of Contents

Note 4 –Loans and Allowance for Loan Losses

Loans held for investment are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company defers and amortizes net loan origination fees and costs as an adjustment to yield. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.

The Company has certain lending policies and procedures in place that are designed to maximize loan income with an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis and makes changes as appropriate. Management receives and reviews frequent reports related to loan originations, quality, concentrations, delinquencies, non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions, both by type of loan and geographic location.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. Underwriting standards are designed to determine whether the borrower possesses sound business ethics and practices and to evaluate current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory and include personal guarantees.

Agricultural loans are subject to underwriting standards and processes similar to commercial loans. These agricultural loans are based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most agricultural loans are secured by the agriculture related assets being financed, such as farm land, cattle or equipment and include personal guarantees.

Real estate loans are also subject to underwriting standards and processes similar to commercial and agricultural loans. These loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. The repayment of real estate loans is generally largely dependent on the successful operation of the property securing the loans or the business conducted on the property securing the loan. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s real estate portfolio are generally diverse in terms of type and geographic location. This diversity helps reduce the exposure to adverse economic events that affect any single market or industry. Generally, real estate loans are owner occupied which further reduces the Company’s risk.

Consumer loan underwriting utilizes methodical credit standards and analysis to supplement the Company’s underwriting policies and procedures. The Company’s loan policy addresses types of consumer loans that may be originated and the collateral, if secured, which must be perfected. The relatively smaller individual dollar amounts of consumer loans that are spread over numerous individual borrowers also minimize the Company’s risk.

 

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Table of Contents

The allowance is an amount management believes is appropriate to absorb probable losses that have been incurred on existing loans as of the balance sheet date based upon management’s review and evaluation of the loan portfolio. The allowance for loan losses is comprised of three elements: (i) specific reserves determined in accordance with current authoritative accounting guidance based on probable losses on specific classified loans; (ii) general reserve determined in accordance with current authoritative accounting guidance that considers historical loss rates; and (iii) qualitative reserves determined in accordance with current authoritative accounting guidance based upon general economic conditions and other qualitative risk factors both internal and external to the Company. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the appropriateness of the allowance is based on general economic conditions, the financial condition of borrowers, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our general reserve, the loan portfolio, less cash secured loans, government guaranteed loans and classified loans, is multiplied by the Company’s historical loss rate. Our methodology is constructed so that specific allocations are increased in accordance with deterioration in credit quality and a corresponding increase in risk of loss on a particular loan. In addition, we adjust our allowance for qualitative factors such as current local economic conditions and trends, including, without limitations, unemployment, changes in lending staff, policies and procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans. This additional allocation based on qualitative factors serves to compensate for additional areas of uncertainty inherent in our portfolio that are not reflected in our historic loss factors.

Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A further downturn in the economy and employment could result in increased levels of non-performing assets and charge-offs, increased loan provisions and reductions in income. Additionally, bank regulatory agencies periodically review our allowance for loan losses and could require additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

Accrual of interest is discontinued on a loan and payments are applied to principal when management believes, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of interest is doubtful. Except consumer loans, generally all loans past due greater than 90 days, based on contractual terms, are placed on non-accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Consumer loans are generally charged-off when a loan becomes past due 90 days. For other loans in the portfolio, facts and circumstances are evaluated in making charge-off decisions.

Loans are considered impaired when, based on current information and events, management determines that it is probable we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

The Company’s policy requires measurement of the allowance for an impaired, collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan’s observable market price. At March 31, 2013 and 2012, and December 31, 2012, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral.

 

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Table of Contents

From time to time, the Company modifies its loan agreement with a borrower. A modified loan is considered a troubled debt restructuring when two conditions are met: (i) the borrower is experiencing financial difficulty and (ii) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit risk characteristics. Modifications to loan terms may include a lower interest rate, a reduction of principal, or a longer term to maturity. To date, these troubled debt restructurings have been such that, after considering economic and business conditions and collection efforts, the collection of interest is doubtful and therefore the loan has been placed on non-accrual. Each of these loans is evaluated for impairment and a specific reserve is recorded based on probable losses, taking into consideration the related collateral and modified loan terms and cash flow. As of March 31, 2013 and 2012, and December 31, 2012, all of the Company’s troubled debt restructured loans are included in the non-accrual totals.

The Company originates certain mortgage loans for sale in the secondary market. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value on an aggregate basis. Loans held for sale totaled $10,122,000, $5,695,000 and $11,457,000, at March 31, 2013 and 2012 and December 31, 2012, respectively, in which the carrying amounts approximate fair value. The mortgage loan sales contracts contain indemnification clauses should the loans default, generally in the first three to six months, or if documentation is determined not to be in compliance with regulations. The Company’s historic losses as a result of these indemnities have been insignificant.

Major classifications of loans held for investment are as follows (in thousands):

 

     March 31,      December 31,
2012
 
     2013      2012     

Commercial

   $ 513,422       $ 433,351       $ 509,609   

Agricultural

     55,247         57,977         68,306   

Real estate

     1,275,564         1,083,244         1,226,823   

Consumer

     283,782         218,600         272,428   
  

 

 

    

 

 

    

 

 

 

Total loans held for investment

   $ 2,128,015       $ 1,793,172       $ 2,077,166   
  

 

 

    

 

 

    

 

 

 

The Company’s non-accrual loans, loans still accruing and past due 90 days or more and restructured loans are as follows (in thousands):

 

     March 31,      December 31,
2012
 
     2013      2012     

Non-accrual loans

   $ 22,509       $ 20,963       $ 21,800   

Loans still accruing and past due 90 days or more

     24         53         97   

Restructured loans*

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,533       $ 21,016       $ 21,897   
  

 

 

    

 

 

    

 

 

 

 

* Restructured loans whose interest collection, after considering economic and business conditions and collection efforts, is doubtful are included in non-accrual loans.

 

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Table of Contents

The Company’s recorded investment in impaired loans and the related valuation allowance are as follows (in thousands):

 

March 31, 2013

 

March 31, 2012

 

December 31, 2012

Recorded

Investment

 

Valuation

Allowance

 

Recorded

Investment

 

Valuation

Allowance

 

Recorded

Investment

 

Valuation

Allowance

$ 22,509   $5,793   $20,963   $5,357   $21,800   $6,010

 

 

 

 

 

 

 

 

 

 

 

The average recorded investment in impaired loans for the three months ended March 31, 2013 and 2012 and the year ended December 31, 2012 was approximately $23,163,000, $21,957,000 and $24,025,000, respectively. The Company had $25,718,000, $28,868,000 and $25,462,000 in non-accrual, past due 90 days still accruing and restructured loans and foreclosed assets at March 31, 2013 and 2012, and December 31, 2012, respectively. Non-accrual loans totaled $22,509,000, $20,963,000 and $21,800,000, respectively, and consisted of the following amounts by type (in thousands):

 

     March 31,      December 31,
2012
 
     2013      2012     

Commercial

   $ 1,133       $ 3,665       $ 2,251   

Agricultural

     473         923         372   

Real estate

     20,502         16,026         18,698   

Consumer

     401         349         479   
  

 

 

    

 

 

    

 

 

 

Total

   $ 22,509       $ 20,963       $ 21,800   
  

 

 

    

 

 

    

 

 

 

No additional funds are committed to be advanced in connection with impaired loans.

The Company’s impaired loans and related allowance as of March 31, 2013 and 2012, and December 31, 2012, are summarized in the following table (in thousands). No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

March 31, 2013

   Unpaid
Contractual

Principal
Balance
     Recorded
Investment With
No Allowance
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Three-month
Average
Recorded
Investment
 

Commercial

   $ 1,555       $ 25       $ 1,108       $ 1,133       $ 555       $ 1,232   

Agricultural

     489         25         448         473         169         483   

Real Estate

     24,937         1,956         18,546         20,502         4,901         21,028   

Consumer

     466         77         324         401         168         420   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 27,447       $ 2,083       $ 20,426       $ 22,509       $ 5,793       $ 23,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

March 31, 2012

   Unpaid
Contractual

Principal
Balance
     Recorded
Investment With
No Allowance
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Three-month
Average
Recorded
Investment
 

Commercial

   $ 4,218       $ 24       $ 3,641       $ 3,665       $ 1,990       $ 3,817   

Agricultural

     948         —           923         923         170         922   

Real Estate

     20,058         3,470         12,556         16,026         3,082         16,838   

Consumer

     414         55         294         349         115         380   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 25,638       $ 3,549       $ 17,414       $ 20,963       $ 5,357       $ 21,957   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2012

   Unpaid
Contractual

Principal
Balance
     Recorded
Investment With
No Allowance
     Recorded
Investment
With
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Year-to-Date
Average
Recorded
Investment
 

Commercial

   $ 2,677       $ 20       $ 2,231       $ 2,251       $ 1,350       $ 2,966   

Agricultural

     381         —           372         372         131         437   

Real Estate

     22,569         2,049         16,649         18,698         4,356         20,164   

Consumer

     543         115         364         479         173         458   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 26,170       $ 2,184       $ 19,616       $ 21,800       $ 6,010       $ 24,025   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The Company recognized interest income on impaired loans prior to being recognized as impaired of approximately $384,000 during the year ended December 31, 2012. Such amounts for the three-month period ended March 31, 2013 and 2012 were not significant.

From a credit risk standpoint, the Company classifies its loans in one of four categories: (i) pass, (ii) special mention, (iii) substandard, or (iv) doubtful. Loans classified as loss are charged-off.

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on our credits as part of our on-going monitoring of the credit quality of our loan portfolio. Ratings are adjusted to reflect the degree of risk and loss that are felt to be inherent in each credit as of each monthly reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on non-accrual.

At March 31, 2013 and December 31, 2012, the following summarizes the Company’s internal ratings of its loans held for investment (in thousands):

 

March 31, 2013

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 501,859       $ 2,083       $ 9,449       $ 31       $ 513,422   

Agricultural

     51,321         337         3,582         7         55,247   

Real Estate

     1,222,112         15,015         38,281         156         1,275,564   

Consumer

     282,545         349         870         18         283,782   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,057,837       $ 17,784       $ 52,182       $ 212       $ 2,128,015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2012

   Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial

   $ 498,188       $ 2,193       $ 9,198       $ 30       $ 509,609   

Agricultural

     64,397         342         3,559         8         68,306   

Real Estate

     1,176,330         14,680         35,673         140         1,226,823   

Consumer

     271,114         382         911         21         272,428   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,010,029       $ 17,597       $ 49,341       $ 199       $ 2,077,166   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

At March 31, 2013 and December 31, 2012, the Company’s past due loans are as follows (in thousands):

 

March 31, 2013

   15-59
Days

Past
Due*
     60-89
Days

Past
Due
     Greater
Than

90
Days
     Total
Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 4,146       $ 307       $ 283       $ 4,736       $ 508,686       $ 513,422       $ 3   

Agricultural

     641         16         —           657         54,590         55,247         —     

Real Estate

     14,962         1,653         1,907         18,522         1,257,042         1,275,564         —     

Consumer

     1,629         227         144         2,000         281,782         283,782         21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 21,378       $ 2,203       $ 2,334       $ 25,915       $ 2,102,100       $ 2,128,015       $ 24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2012

   15-59
Days

Past
Due*
     60-89
Days

Past
Due
     Greater
Than

90
Days
     Total
Past
Due
     Current      Total Loans      90 Days
Past Due
Still
Accruing
 

Commercial

   $ 1,708       $ 470       $ 247       $ 2,425       $ 507,184       $ 509,609       $ —     

Agricultural

     467         95         —           562         67,744         68,306         —     

Real Estate

     10,141         2,711         1,237         14,089         1,212,734         1,226,823         34   

Consumer

     1,660         287         163         2,110         270,318         272,428         63   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 13,976       $ 3,563       $ 1,647       $ 19,186       $ 2,057,980       $ 2,077,166       $ 97   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* The Company monitors commercial, agricultural and real estate loans after such loans are 15 days past due. Consumer loans are monitored after such loans are 30 days past due.

The allowance for loan losses as of March 31, 2013 and 2012, and December 31, 2012, is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the probable losses in various categories of the loan portfolio, which are identified below (in thousands):

 

     March 31,      December 31,
2012
 
     2013      2012     

Allowance for loan losses provided for:

        

Loans specifically evaluated as impaired

   $ 5,793       $ 5,357       $ 6,010   

Remaining portfolio

     28,879         29,172         28,829   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 34,672       $ 34,529       $ 34,839   
  

 

 

    

 

 

    

 

 

 

The following table details the allowance for loan losses at March 31, 2013 and December 31, 2012 by portfolio segment (in thousands). Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

March 31, 2013

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 2,542       $ 388       $ 8,983       $ 315       $ 12,228   

Loans collectively evaluated for impairment

     3,962         1,078         15,878         1,526         22,444   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,504       $ 1,466       $ 24,861       $ 1,841       $ 34,672   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2012

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 3,253       $ 388       $ 8,380       $ 308       $ 12,329   

Loans collectively evaluated for impairment

     4,090         1,153         15,683         1,584         22,510   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,343       $ 1,541       $ 24,063       $ 1,892       $ 34,839   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Changes in the allowance for loan losses for the three months ended March 31, 2013 and 2012 are summarized as follows (in thousands):

 

Three months ended

March 31, 2013

   Commercial     Agricultural     Real Estate     Consumer     Total  

Beginning balance

   $ 7,343      $ 1,541      $ 24,063      $ 1,892      $ 34,839   

Provision for loan losses

     (672     (86     1,120        39        401   

Recoveries

     121        11        28        95        255   

Charge-offs

     (288     —          (350     (185     (823
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,504      $ 1,466      $ 24,861      $ 1,841      $ 34,672   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Three months ended

March 31, 2012

   Commercial     Agricultural     Real Estate     Consumer     Total  

Beginning balance

   $ 9,664      $ 1,482      $ 21,533      $ 1,636      $ 34,315   

Provision for loan losses

     94        (119     1,161        160        1,296   

Recoveries

     103        12        113        95        323   

Charge-offs

     (249     (22     (972     (162     (1,405
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 9,612      $ 1,353      $ 21,835      $ 1,729      $ 34,529   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s recorded investment in loans as of March 31, 2013 and December 31, 2012 related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology was as follows (in thousands):

 

March 31, 2013

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 11,563       $ 3,926       $ 53,452       $ 1,237       $ 70,178   

Loans collectively evaluated for impairment

     501,859         51,321         1,222,112         282,545         2,057,837   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 513,422       $ 55,247       $ 1,275,564       $ 283,782       $ 2,128,015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2012

   Commercial      Agricultural      Real Estate      Consumer      Total  

Loans individually evaluated for impairment

   $ 11,421       $ 3,909       $ 50,493       $ 1,314       $ 67,137   

Loans collectively evaluated for impairment

     498,188         64,397         1,176,330         271,114         2,010,029   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 509,609       $ 68,306       $ 1,226,823       $ 272,428       $ 2,077,166   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s loans that were modified in the three months ended March 31, 2013 and 2012 and considered a troubled debt restructuring are as follows (dollars in thousands):

 

     Three months ended March 31, 2013      Three months ended March 31, 2012  
            Pre-Modification      Post-
Modification
            Pre-Modification      Post-
Modification
 
            Recorded      Recorded             Recorded      Recorded  
     Number      Investment      Investment      Number      Investment      Investment  

Commercial

     2       $ 120       $ 120         4       $ 127       $ 127   

Agricultural

     1         24         24         2         108         108   

Real Estate

     4         796         796         13         3,803         3,803   

Consumer

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7       $ 940       $ 940         19       $ 4,038       $ 4,038   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The balances below provide information as to how the loans were modified as troubled debt restructured loans during the three months ended March 31, 2013 and 2012 (in thousands):

 

     Three months ended March 31, 2013      Three months ended March 31, 2012  
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and

Maturity
     Adjusted
Interest
Rate
     Extended
Maturity
     Combined
Rate and

Maturity
 

Commercial

   $ —         $ 120       $ —         $ 17       $ 62       $ 48   

Agricultural

     —           24         —           —           13         95   

Real Estate

     272         350         174         —           —           3,803   

Consumer

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 272       $ 494       $ 174       $ 17       $ 75       $ 3,946   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

During the three months ended March 31, 2013, 11 loans totaling $1,167,000 that had been modified as a troubled debt restructured loan within the previous 12 months defaulted on the modified loan. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due or results in the foreclosure and repossession of the applicable collateral. There were no such defaults for the three months ended March 31, 2012. The loans are as follows (dollars in thousands):

 

     Three months ended March 31, 2013  
     Number      Balance  

Commercial

     5       $ 217   

Agriculture

     —           —     

Real Estate

     5         931   

Consumer

     1         19   
  

 

 

    

 

 

 

Total

     11       $ 1,167   
  

 

 

    

 

 

 

As of March 31, 2013, the Company has no commitments to lend additional funds to loan customers whose terms have been modified in troubled debt restructurings.

Our subsidiary bank has established a line of credit with the Federal Home Loan Bank of Dallas to provide liquidity and meet pledging requirements for those customers eligible to have securities pledged to secure certain uninsured deposits. At March 31, 2013, approximately $1,118,519,000 in loans held by the bank were subject to blanket liens as security for these lines of credit. At March 31, 2013, $68,600,000 in letters of credit issued by the Federal Home Loan Bank of Dallas were outstanding under these lines of credit. The letters of credit were pledged as collateral for public funds held by our bank.

Note 5 – Income Taxes

Income tax expense was $6,182,000 for the first quarter in 2013 as compared to $6,035,000 for the same period in 2012. Our effective tax rates on pretax income were 25.0% and 25.4% for the first quarter of 2013 and 2012, respectively. The effective tax rates differ from the statutory federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans, the deductibility of dividends paid to our employee stock ownership plan and Texas state taxes.

Note 6 – Stock Based Compensation

The Company grants incentive stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant to employees. No options have been granted in 2013 or 2012. The Company recorded stock option expense totaling approximately $88,000 thousand and $88,000, respectively, for the three-month periods ended March 31, 2013 and 2012. The additional disclosure requirements under authoritative accounting guidance have been omitted due to immateriality.

 

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Table of Contents

Note 7 – Pension Plan

The Company’s defined benefit pension plan was frozen effective January 1, 2004, whereby no additional years of service will accrue to participants, unless the pension plan is reinstated at a future date. The pension plan covered substantially all of the Company’s employees at the time. The benefits for each employee were based on years of service and a percentage of the employee’s qualifying compensation during the final years of employment. The Company’s funding policy was and is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding standards. Contributions to the pension plan, prior to freezing the plan, were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. As a result of the Pension Protection Act of 2006 (the “Protection Act”), the Company will be required to contribute amounts in future years to fund any shortfalls. The Company has evaluated the provisions of the Protection Act as well as the Internal Revenue Service’s funding standards to develop a plan for funding in future years. The Company made a contribution totaling $2,000,000 in 2012 and has to date made no contributions in 2013.

Net periodic benefit costs totaling $208,000 and $185,000 were recorded, respectively, for the three months ended March 31, 2013 and 2012.

Note 8 – Recently Issued Authoritative Accounting Guidance

In 2011 and 2013, the Financial Accounting Standards Board (the “FASB”) amended its authoritative guidance related to offsetting assets and liabilities to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sales and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. The new guidance was effective for annual and interim periods beginning on January 1, 2013, and did not have a significant impact on the Company’s financial statements.

In 2013, the FASB amended its authoritative guidance related to reporting of reclassifications out of other comprehensive earnings. The new guidance sets requirements for presentation for significant items reclassified to net earnings during the period presented. The new guidance was effective for annual and interim periods beginning on January 1, 2013 and have been included in these financial statements.

Note 9 – Fair Value Disclosures

The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

The authoritative accounting guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement costs). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those

 

20


Table of Contents

that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

   

Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

   

Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (for example, interest rates, volatilities, prepayment speeds, loss severities, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

   

Level 3 Inputs – Significant unobservable inputs that reflect an entity’s own assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Securities classified as available-for-sale and trading are reported at fair value utilizing Level 1 and Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market spreads, cash flows, the United States Treasury yield curve, live trading levels, trade execution data, dealer quotes, market consensus prepayments speeds, credit information and the security’s terms and conditions, among other items. Securities are considered to be measured with Level 1 inputs at the time of purchase and for 30 days following. After 30 days, the majority of securities are transferred to Level 2 as they are considered to be measured with Level 2 inputs, with the exception of U. S. Treasury securities and any other security for which there remain Level 1 inputs. Transfers are recognized on the actual date of transfer.

There were no transfers between Level 2 and Level 3 during the three months ended March 31, 2013 or 2012.

 

21


Table of Contents

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

Available-for-sale investment securities:

           

U. S. Treasury securities

   $ 6,039       $ —         $ —         $ 6,039   

Obligations of U. S. government sponsored-enterprises and agencies

     16,844         176,520         —           193,364   

Obligations of states and political subdivisions

     86,393         831,522         —           917,915   

Corporate bonds

     —           113,067         —           113,067   

Residential mortgage-backed securities

     37,972         578,594         —           616,566   

Commercial mortgage-backed securities

     10,556         96,489         —           107,045   

Other securities

     4,155         —           —           4,155   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 161,959       $ 1,796,192       $ —         $ 1,958,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a non-recurring basis include the following at March 31, 2013:

Impaired Loans – Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data, or Level 3 input based on the discounting of the collateral. At March 31, 2013, impaired loans with a carrying value of $22,509,000 were reduced by specific valuation reserves totaling $5,793,000 resulting in a net fair value of $16,716,000.

Loans Held for Sale – Loans held for sale are reported at the lower of cost or fair value. In determining whether the fair value of loans held for sale is less than cost when quoted market prices are not available, the Company considers investor commitments/contracts. These loans are considered Level 2 of the fair value hierarchy. At March 31, 2013, the Company’s mortgage loans held for sale were recorded at cost as fair value exceeded cost.

Certain non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include other real estate owned, goodwill and other intangible assets and other non-financial long-lived assets. Non-financial assets measured at fair value on a non-recurring basis during the three months ended March 31, 2013 and 2012 include other real estate owned which, subsequent to their initial transfer to other real estate owned from loans, were re-measured at fair value through a write-down included in gain (loss) on sale of foreclosed assets. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs based on observable market data, generally third-party appraisals, or Level 3 inputs based on customized discounting criteria. These appraisals are evaluated individually and discounted are as necessary due to the age of the appraisal, lack of comparable sales, expected holding periods of property or special use type of the property. Such discounts vary by appraisal based on

 

22


Table of Contents

the above factors but generally range from 5% to 25% of the appraised value. Reevaluation of other real estate owned is performed at least annually as required by regulatory guidelines or more often if particular circumstances arise. The following table presents other real estate owned that were re-measured subsequent to their initial transfer to other real estate owned (dollars in thousands):

 

     Three months ended
March 31,
 
     2013     2012  

Carrying value of other real estate owned prior to re-measurement

   $ 1,827      $ 417   

Write-downs included in gain (loss) on sale of other real estate owned

     (304     (101
  

 

 

   

 

 

 

Fair value

   $ 1,523      $ 316   
  

 

 

   

 

 

 

At March 31, 2013 and 2012, and December 31, 2012, other real estate owned totaled $3,052,000, $7,815,000 and $3,505,000, respectively.

The Company is required under current authoritative accounting guidance to disclose the estimated fair value of their financial instrument assets and liabilities including those subject to the requirements discussed above. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments, as defined. Many of the Company’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Cash and due from banks, federal funds sold, interest-bearing deposits and time deposits in banks and accrued interest receivable and payable are liquid in nature and considered Level 1 or 2 of the fair value hierarchy.

Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities and are considered Levels 2 and 3 of the fair value hierarchy. Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value and are considered Level 1 of the fair value hierarchy.

The carrying value and the estimated fair value of the Company’s contractual off-balance-sheet unfunded lines of credit, loan commitments and letters of credit, which are generally priced at market at the time of funding, are not material.

 

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Table of Contents

The estimated fair values and carrying values of all financial instruments under current authoritative guidance at March 31, 2013 and December 31, 2012, were as follows (in thousands):

 

     March 31,      December 31,
     2013      2012
     Carrying      Estimated      Carrying      Estimated      Fair Value
     Value      Fair Value      Value      Fair Value      Hierarchy

Cash and due from banks

   $ 113,958       $ 113,958       $ 207,018       $ 207,018       Level 1

Federal funds sold

     3,175         3,175         14,045         14,045       Level 1

Interest-bearing deposits in banks

     20,065         20,065         139,676         139,676       Level 1

Interest-bearing time deposits in banks

     45,172         45,415         49,005         49,288       Level 2

Available-for-sale securities

     1,958,151         1,958,151         1,819,035         1,819,035       Levels 1 and 2

Held-to-maturity securities

     903         920         1,061         1,080       Level 2

Loans

     2,103,465         2,120,669         2,053,784         2,081,091       Level 3

Accrued interest receivable

     20,904         20,904         23,122         23,122       Level 2

Deposits with stated maturities

     620,848         621,946         637,040         638,227       Level 2

Deposits with no stated maturities

     2,929,278         2,929,278         2,995,544         2,995,544       Level 1

Short term borrowings

     263,345         263,345         259,697         259,697       Level 2

Accrued interest payable

     239         239         287         287       Level 2

Note 10 – Acquisition Definitive Agreement Signed

On February 20, 2013, the Company announced that it has entered into a definitive agreement to acquire Orange Savings Bank, SSB in Orange, Texas for an expected combination of cash and stock purchase price of approximately $56.0 million. Pending regulatory and shareholder approval, the acquisition is expected to be finalized in the second quarter of 2013.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to, those listed in “Item 1A- Risk Factors” in our Annual Report on Form 10-K and the following:

 

   

general economic conditions, including our local, state and national real estate markets and employment trends;

 

   

volatility and disruption in national and international financial markets;

 

   

government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau and the ratios of proposed rule making per Basel III;

 

   

political instability;

 

   

the ability of the Federal government to deal with the slowdown of the national economy and the fiscal cliff;

 

   

competition from other financial institutions and financial holding companies;

 

   

the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

 

   

changes in the demand for loans;

 

   

fluctuations in the value of collateral securing our loan portfolio and in the level of the allowance for loan losses;

 

   

the accuracy of our estimates of future loan losses;

 

   

the accuracy of our estimates and assumptions regarding the performance of our securities portfolio;

 

   

soundness of other financial institutions with which we have transactions;

 

   

inflation, interest rate, market and monetary fluctuations;

 

   

changes in consumer spending, borrowing and savings habits;

 

   

our ability to attract deposits;

 

   

changes in our liquidity position;

 

   

changes in the reliability of our vendors, internal control system or information systems;

 

   

our ability to attract and retain qualified employees;

 

   

acquisitions and integration of acquired businesses;

 

   

the possible impairment of goodwill associated with our acquisitions;

 

   

consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors;

 

   

expansion of operations, including branch openings, new product offerings and expansion into new markets;

 

   

changes in compensation and benefit plans; and

 

   

acts of God or of war or terrorism.

 

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Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Introduction

As a financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary bank. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.

The following discussion of operations and financial condition should be read in conjunction with the financial statements and accompanying footnotes included in Item 1 of this Form 10-Q as well as those included in the Company’s 2012 Annual Report on Form 10-K.

Critical Accounting Policies

We prepare consolidated financial statements based on generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.

We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.

We deem our most critical accounting policies to be (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period. A discussion of (1) our allowance for loan losses and our provision for loan losses and (2) our valuation of securities is included in note 4 and note 3, respectively, to our notes to consolidated financial statements (unaudited) which begins on page 7.

Consolidation of Bank Charters

Effective December 30, 2012, the Company consolidated its eleven bank charters into one charter. The Company cited regulatory, compliance and technology complexities and the opportunity for cost savings as its reason for making this change. The Company noted it expects to operate its subsidiary bank as it previously did with eleven charters with local management and board decisions to benefit the customers and communities it serves.

 

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Results of Operations

Performance Summary. Net earnings for the first quarter of 2013 were $18.58 million compared to $17.76 million for the same period in 2012, or a 4.62% increase over the same period in 2012.

Basic earnings per share for the first quarter of 2013 were $0.59 compared to $0.56 for the same quarter last year. The return on average assets was 1.71% for the first quarter of 2013, as compared to 1.73% for the same quarter of 2012. The return on average equity was 13.41% for the first quarter of 2013 as compared to 13.79% for the same quarter of 2012.

Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits.

Tax-equivalent net interest income was $42.47 million for the first quarter of 2013, as compared to $41.75 million for the same period last year. The increase in 2013 compared to 2012 was largely attributable to the decrease in rate of interest bearing liabilities. Average earning assets increased $283.68 million for the first quarter of 2013 over the same period in 2012. Average tax exempt securities and average loans increased $133.87 million and $326.95 million, respectively, for the first quarter of 2013 over the first quarter of 2012. Average interest bearing liabilities increased $97.27 million for the first quarter of 2013, as compared to the same period in 2012. The yield on earning assets decreased 27 basis points during the first quarter of 2013, whereas the rate paid on interest-bearing liabilities decreased 11 basis points in the first quarter of 2013 primarily due to the effects of lower interest rates.

Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.

Table 1 — Changes in Interest Income and Interest Expense (in thousands):

 

     Three Months Ended March 31,
2013 Compared to Three Months
Ended

March 31, 2012
 
     Change
Attributable to
    Total
Change
 
     Volume     Rate    

Short-term investments

   $ (8   $ (28   $ (36

Taxable investment securities

     (1,288     (1,141     (2,429

Tax-exempt investment securities (1)

     1,816        (1,118     698   

Loans (1) (2)

     4,319        (2,474     1,845   
  

 

 

   

 

 

   

 

 

 

Interest income

     4,839        (4,761     78   

Interest-bearing deposits

     32        (647     (615

Short-term borrowings

     6        (27     (21
  

 

 

   

 

 

   

 

 

 

Interest expense

     38        (674     (636
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 4,801      $ (4,087   $ 714   
  

 

 

   

 

 

   

 

 

 

 

(1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(2) Non-accrual loans are included in loans.

 

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The net interest margin for the first quarter of 2013 was 4.19%, a decrease of 20 basis points from the same period in 2012. The target Federal funds rate was reduced to a range of zero to 25 basis points in December 2008. The low level of interest rates has reduced the yields on our short-term investments and investment securities as the proceeds from maturing investment securities have been invested at much lower rates. We have been able to partially mitigate the impact of low short-term interest rates by establishing minimum interest rates on certain of our loans, improving the pricing for loan risk, and reducing rates paid on interest bearing liabilities. We expect interest rates to remain at the current low levels until 2015 as announced by the Federal Reserve, which will continue to place pressure on our interest margin.

The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2.

Table 2 — Average Balances and Average Yields and Rates (in thousands, except percentages):

 

     Three months ended March 31,  
     2013     2012  
     Average
Balance
    Income/
Expense
     Yield/
Rate
    Average
Balance
    Income/
Expense
     Yield/
Rate
 

Assets

              

Short-term investments (1)

   $ 137,595      $ 176         0.56   $ 136,657      $ 211         0.63

Taxable investment securities (2)

     1,038,706        6,375         2.45        1,216,783        8,804         2.89   

Tax-exempt investment securities (2)(3)

     824,947        10,073         4.88        691,076        9,375         5.43   

Loans (3)(4)

     2,111,138        26,747         5.14        1,784,192        24,901         5.61   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     4,112,386        43,371         4.28        3,828,708        43,291         4.55   

Cash and due from banks

     129,945             125,443        

Bank premises and equipment, net

     85,476             77,535        

Other assets

     46,417             50,754        

Goodwill and other intangible assets, net

     71,968             72,099        

Allowance for loan losses

     (34,900          (34,462     
  

 

 

        

 

 

      

Total assets

   $ 4,411,292           $ 4,120,077        
  

 

 

        

 

 

      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits

   $ 2,320,932      $ 868         0.15   $ 2,252,481      $ 1,482         0.26

Short-term borrowings

     270,561        37         0.06        241,745        58         0.10   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     2,591,493        905         0.14        2,494,226        1,540         0.25   

Noninterest-bearing deposits

     1,205,522             1,055,654        

Other liabilities

     52,630             52,514        
  

 

 

        

 

 

      

Total liabilities

     3,849,645             3,602,394        

Shareholders’ equity

     561,647             517,683        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 4,411,292           $ 4,120,077        
  

 

 

        

 

 

      

Net interest income

     $ 42,466           $ 41,751      
    

 

 

        

 

 

    

Rate Analysis:

              

Interest income/earning assets

          4.28          4.55

Interest expense/earning assets

          0.11             0.16   
       

 

 

        

 

 

 

Net yield on earning assets

          4.19          4.39

 

(1) Short-term investments are comprised of Fed Funds sold, interest-bearing deposits in banks and interest-bearing time deposits in banks.
(2) Average balances include unrealized gains and losses on available-for-sale securities.
(3) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.
(4) Non-accrual loans are included in loans.

Noninterest Income. Noninterest income for the first quarter of 2013 was $13.96 million, an increase of $662 thousand over the same period in 2012. Trust fees increased $339 thousand and real estate mortgage operations increased $334 thousand. The increase in trust fees reflects an increase in estate fees, fees from mineral management and an increase in assets under management over the prior year from both improved market conditions and growth in assets managed. The fair value of our trust assets managed,

 

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which are not reflected in our consolidated balance sheet, totaled $3.02 billion at March 31, 2013 as compared to $2.63 billion for the same date in 2012. Real estate mortgage income increased primarily due to a stronger housing market and increased market share.

Offsetting these increases was a decrease in our net gain on sale of available for sale securities of $124 thousand and a loss on sale of foreclosed assets of $322 thousand.

Table 3 — Noninterest Income (in thousands):

 

     Three Months Ended
March 31,
 
     2013     Increase
(Decrease)
    2012  

Trust fees

   $ 3,793      $ 339      $ 3,454   

Service charges on deposit accounts

     3,895        13        3,882   

ATM, interchange and credit card fees

     3,729        53        3,676   

Real estate mortgage operations

     1,384        334        1,050   

Net gain on sale of available-for-sale securities

     222        (124     346   

Net gain (loss) on sale of foreclosed assets

     (316     (322     6   

Other:

      

Check printing fees

     50        9        41   

Safe deposit rental fees

     165        (1     166   

Credit life and debt protection fees

     40        4        36   

Brokerage commissions

     109        68        41   

Interest on loan recoveries

     238        125        113   

Gain (loss) on sale of assets, net

     168        46        122   

Miscellaneous income

     483        118        365   
  

 

 

   

 

 

   

 

 

 

Total other

     1,253        369        884   
  

 

 

   

 

 

   

 

 

 

Total Noninterest Income

   $ 13,960      $ 662      $ 13,298   
  

 

 

   

 

 

   

 

 

 

Noninterest Expense. Total noninterest expense for the first quarter of 2013 was $27.47 million, an increase of $1.00 million, or 3.79%, as compared to the same period in 2012. An important measure in determining whether a banking company effectively manages noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for the first quarter of 2013 was 48.68%, compared to 48.08% from the same period in 2012.

Salaries and employee benefits for the first quarter of 2013 totaled $15.18 million, an increase of $951 thousand compared to 2012. The increase was largely the result of additional employees to staff new branches and annual pay increases.

All other categories of noninterest expense for the first quarter of 2013 totaled $12.29 million, an increase of $52 thousand, or 0.42%, as compared to the same period in 2012. Categories of noninterest expense with increases included ATM, interchange and credit card expense, equipment expense and professional and service fees. Offsetting these increases were decreases in operation and other losses, legal fees and regulatory exam fees. Included in noninterest expense for the first quarter of 2013 are costs, primarily legal and travel, totaling $143 thousand related to the Company’s recently announced acquisition of Orange Savings Bank, SSB, which is expected to close in the second quarter of 2013.

 

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Table 4 — Noninterest Expense (in thousands):

 

     Three Months Ended March 31,  
     2013      Increase
(Decrease)
    2012  

Salaries

   $ 11,381       $ 611      $ 10,770   

Medical

     1,017         214        803   

Profit sharing

     1,079         36        1,043   

Pension

     208         23        185   

401(k) match expense

     381         25        356   

Payroll taxes

     1,026         42        984   

Stock option expense

     88         —          88   
  

 

 

    

 

 

   

 

 

 

Total salaries and employee benefits

     15,180         951        14,229   

Net occupancy expense

     1,766         29        1,737   

Equipment expense

     2,281         173        2,108   

FDIC assessment fees

     572         45        527   

ATM, interchange and credit card expense

     1,340         91        1,249   

Professional and service fees

     803         66        737   

Printing, stationery and supplies

     472         (33     505   

Amortization of intangible assets

     10         (34     44   

Other:

       

Data processing fees

     59         (4     63   

Postage

     378         46        332   

Advertising

     552         32        520   

Correspondent bank service charges

     202         2        200   

Telephone

     402         1        401   

Public relations and business development

     442         20        422   

Directors’ fees

     231         29        202   

Audit and accounting fees

     381         39        342   

Legal fees

     143         (106     249   

Regulatory exam fees

     197         (62     259   

Travel

     171         6        165   

Courier expense

     188         (4     192   

Operational and other losses

     192         (195     387   

Other real estate

     117         (6     123   

Other miscellaneous expense

     1,392         (83     1,475   
  

 

 

    

 

 

   

 

 

 

Total other

     5,047         (285     5,332   
  

 

 

    

 

 

   

 

 

 

Total Noninterest Expense

   $ 27,471       $ 1,003      $ 26,468   
  

 

 

    

 

 

   

 

 

 

 

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Balance Sheet Review

Loans. Our portfolio is comprised of loans made to businesses, professionals, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary bank. Real estate loans represent loans primarily for 1-4 family residences and owner-occupied commercial real estate. The structure of loans in the real estate mortgage area generally provides re-pricing intervals to minimize the interest rate risk inherent in long-term fixed rate loans. As of March 31, 2013, total loans held for investment were $2.13 billion, an increase of $50.85 million, as compared to December 31, 2012. As compared to December 31, 2012, commercial loans increased $3.8 million, agricultural loans decreased $13.1 million, real estate loans increased $48.7 million, and consumer loans increased $11.4 million. Loans averaged $2.11 billion during the first quarter of 2013, an increase of $326.9 million from the prior year first quarter average balances.

Table 5 — Composition of Loans (in thousands):

 

     March 31,      December  31,
2012
 
     2013      2012     

Commercial

   $ 513,422       $ 433,351       $ 509,609   

Agricultural

     55,247         57,977         68,306   

Real estate

     1,275,564         1,083,244         1,226,823   

Consumer

     283,782         218,600         272,428   
  

 

 

    

 

 

    

 

 

 

Total loans held for investment

   $ 2,128,015       $ 1,793,172       $ 2,077,166   
  

 

 

    

 

 

    

 

 

 

At March 31, 2013, our real estate loans represent approximately 60.2% of our loan portfolio and are comprised of (i) 1-4 family residence loans of 43.6%, (ii) commercial real estate loans of 28.2%, generally owner occupied, (iii) other loans, which includes ranches, hospitals and universities, of 18.6%, (iv) residential development and construction loans of 5.7%, which includes our custom and speculation home construction loans and (v) commercial development and construction loans of 3.9%.

Loans held for sale, consisting of mortgage loans, totaled $10.1 million, $5.7 million and $11.5 million at March 31, 2013 and 2012, and December 31, 2012, respectively, in which the carrying amounts approximate market.

Asset Quality. Our loan portfolios are subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by state and federal bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectability of principal or interest under the original terms becomes doubtful. Nonaccrual, past due 90 days still accruing and restructured loans plus foreclosed assets, were $25.7 million at March 31, 2013, as compared to $28.9 million at March 31, 2012 and $25.5 million at December 31, 2012. As a percent of loans and foreclosed assets, these assets were 1.20% at March 31, 2013, as compared to 1.60% at March 31, 2012 and 1.22% at December 31, 2012. As a percent of total assets, these assets were 0.58% at March 31, 2013 as compared to 0.68% at March 31, 2012 and 0.57% at December 31, 2012. The continued higher levels of these nonperforming assets are the result of ongoing weakness in real estate markets and the national economy. We believe the level of these assets to be manageable at March 31, 2013.

 

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Table 6 — Non-accrual Loans, Loans Still Accruing and Past Due 90 Days or More, Restructured Loans and Foreclosed Assets (in thousands, except percentages):

 

     March 31,     December  31,
2012
 
     2013     2012    

Non-accrual loans

   $ 22,509      $ 20,963      $ 21,800   

Loans still accruing and past due 90 days or more

     24        53        97   

Restructured loans

     —          —          —     

Foreclosed assets

     3,185        7,852        3,565   
  

 

 

   

 

 

   

 

 

 

Total

   $ 25,718      $ 28,868      $ 25,462   
  

 

 

   

 

 

   

 

 

 

As a % of loans and foreclosed assets

     1.20     1.60     1.22

As a % of total assets

     0.58     0.68     0.57

We record interest payments received on non-accrual loans as reductions of principal. Prior to the loans being placed on non-accrual, we recognized interest income on impaired loans as of December 31, 2012 described above of approximately $287 thousand during the year ended December 31, 2012. If interest on these impaired loans had been recognized on a full accrual basis during the year ended December 31, 2012, such income would have approximated $1.67 million. Such amounts for the 2013 and 2012 interim periods were insignificant.

Provision and Allowance for Loan Losses. The allowance for loan losses is the amount we determine as of a specific date to be appropriate to absorb probable losses on existing loans in which full collectability is unlikely based on our review and evaluation of the loan portfolio. For a discussion of our methodology, see note 4 to our notes to consolidated financial statements (unaudited). The provision for loan losses was $401 thousand for the first quarter of 2013, as compared to $1.3 million for the first quarter of 2012. The continued provision for loan losses in 2013 and 2012 reflects the growth in loans and continuing higher levels of nonperforming assets. However, the general stability of our balances in non-accrual loans and reductions in net charge-offs enabled the Company to reduce its provisions in the first quarter of 2013 compared to the prior year. As a percent of average loans, net loan charge-offs were 0.11% for the first quarter of 2013 compared to 0.24% during the first quarter of 2012. The allowance for loan losses as a percent of loans was 1.62% as of March 31, 2013, as compared to 1.67% as of December 31, 2012 and 1.92% as of March 31, 2012. Included in Table 7 is further analysis of our allowance for loan losses compared to charge-offs.

Table 7 — Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):

 

     Three Months Ended
March 31,
 
     2013     2012  

Allowance for loan losses at period end

   $ 34,672      $ 34,529   

Loans held for investment at period end

     2,128,015        1,793,172   

Average loans for period

     2,111,138        1,784,192   

Net charge-offs/average loans (annualized)

     0.11     0.24

Allowance for loan losses/period-end loans

     1.62     1.92

Allowance for loan losses/nonaccrual loans, past due 90 days still accruing and restructured loans

     153.9     164.3

 

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The ratio of our allowance to non-accrual, past due 90 days still accruing and restructured loans has generally trended downward since 2007, as the economic conditions worsened. Although the ratio has declined from prior years when net charge-offs and non-performing asset levels were historically low, management believes the allowance for loan losses is appropriate at March 31, 2013 in spite of these trends.

Interest-Bearing Deposits and Time Deposits in Banks. As of March 31, 2013, our interest-bearing deposits and time deposits were $65.2 million compared with $146.2 million and $188.7 million as of March 31, 2012 and December 31, 2012, respectively. At March 31, 2013, interest-bearing deposits and time deposits in banks included $45.2 million invested in FDIC-insured certificates of deposit, and $19.3 million maintained at the Federal Reserve Bank of Dallas. Interest-bearing deposits in banks results from several factors including cash flows from maturing investment securities, growth in deposits and fluctuating deposits from larger depository customers.

Available-for-Sale and Held-to-Maturity Securities. At March 31, 2013, securities with an amortized cost of $903 thousand were classified as securities held-to-maturity and securities with a fair value of $1.96 billion were classified as securities available-for-sale. As compared to December 31, 2012, the available for sale portfolio, carried at fair value, at March 31, 2013, reflected (i) a decrease of $30.2 million in U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies, (ii) an increase of $74.2 million in obligations of states and political subdivisions, (iii) a decrease of $6.0 million in corporate and other bonds, and (iv) an increase of $101.0 million in mortgage-backed securities. Our mortgage related securities are backed by GNMA, FNMA or FHLMC or are collateralized by securities guaranteed by these agencies.

See note 3 to consolidated financial statements (unaudited) for additional disclosures related to the maturities and fair values of the investment portfolio at March 31, 2013 and December 31, 2012.

Table 8 — Maturities and Yields of Available-for-Sale and Held-to-Maturity Securities Held at March 31, 2013 (in thousands, except percentages):

 

     Maturing  
     One Year
or Less
    After One Year
Through
Five Years
    After Five Years
Through
Ten Years
    After
Ten Years
    Total  

Available-for-Sale:

   Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

U.S. Treasury securities

   $ 6,040         1.78   $ —           —     $ —           —     $ —           —     $ 6,040         1.78

Obligations of U.S. government sponsored-enterprises and agencies

     56,061         2.73        137,303         1.37        —           —          —           —          193,364         1.77   

Obligations of states and political subdivisions

     65,189         5.26        305,109         4.58        519,967         5.40        27,650         5.87        917,915         5.13   

Corporate bonds and other securities

     17,076         4.64        90,049         2.76        10,097         4.36        —           —          117,222         2.79   

Mortgage-backed securities

     20,818         4.47        428,493         2.97        219,778         2.19        54,521         2.73        723,610         2.76   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 165,184         4.11   $ 960,954         3.19   $ 749,842         4.45   $ 82,171         3.78   $ 1,958,151         3.77
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

 

     Maturing  
     One Year
or Less
    After One Year
Through
Five Years
    After Five
Years
Through
Ten Years
    After
Ten Years
    Total  

Held-to-Maturity:

   Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

Obligations of states and political subdivisions

   $ 595         8.03   $ —           —     $ —           —     $ —           —     $ 595         8.03

Mortgage-backed securities

     18         6.62        198         2.82        92         1.78        —           —          308         2.73   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 613         7.99   $ 198         2.82   $ 92         1.78   $ —           —     $ 903         6.22
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

 

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All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 35%. Yields on securities are based on amortized cost. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Maturities of other securities are reported at the sooner of maturity date or call date.

As of March 31, 2013, the investment portfolio had an overall tax equivalent yield of 3.73%, a weighted average life of 4.61 years and modified duration of 4.07 years.

Deposits. Deposits held by subsidiary banks represent our primary source of funding. Total deposits were $3.55 billion as of March 31, 2013, as compared to $3.40 billion as of March 31, 2012. Table 9 provides a breakdown of average deposits and rates paid for the three month period ended March 31, 2013 and 2012.

Table 9 — Composition of Average Deposits (in thousands, except percentages):

 

     Three Months Ended March 31,  
     2013     2012  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing deposits

   $ 1,205,522           $ 1,055,654        

Interest-bearing deposits

          

Interest-bearing checking

     1,005,770         0.11        879,458         0.12   

Savings and money market accounts

     687,143         0.07        628,056         0.14   

Time deposits under $100,000

     277,206         0.28        313,662         0.78   

Time deposits of $100,000 or more

     350,813         0.35        431,305         0.38   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     2,320,932         0.15     2,252,481         0.26
  

 

 

    

 

 

   

 

 

    

 

 

 

Total average deposits

   $ 3,526,454         $ 3,308,135      
  

 

 

      

 

 

    

Short-Term Borrowings. Included in short-term borrowings were federal funds purchased and securities sold under repurchase agreements of $263.3 million and $237.6 million at March 31, 2013 and 2012, respectively. Securities sold under repurchase agreements are generally with significant customers that require short-term liquidity for their funds which we pledge our securities that have a fair value equal to at least the amount of the short-term borrowing. The average balance of federal funds purchased and securities sold under repurchase agreements was $269.6 million and $241.7 million in the first quarters of 2013 and 2012, respectively. The average rates paid on federal funds purchased and securities sold under repurchase agreements was 0.06% and 0.10% for the first quarters of 2013 and 2012, respectively.

Capital Resources

We evaluate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration.

Total shareholders’ equity was $564.3 million, or 12.66% of total assets, at March 31, 2013, as compared to $517.0 million, or 12.23% of total assets, at March 31, 2012. Included in shareholders’ equity at March 31, 2013 and March 31, 2012, were $55.5 million and $52.3 million, respectively, in unrealized gains on investment securities available-for-sale, net of related income taxes. For the first quarter of 2013, total shareholders’ equity averaged $561.6 million, or 12.73% of average assets, as compared to $517.7 million, or 12.56% of average assets, during the same period in 2012.

 

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Banking regulators measure capital adequacy by means of the risk-based capital ratio and leverage ratio. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories ranging from 0% to 100%. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders’ equity less intangible assets by quarter-to-date average assets less intangible assets. Regulatory minimums to be designated “well capitalized” for total risk-based, Tier 1 risk based and leverage ratios are 10.00%, 6.00% and 5.00%, respectively. As of March 31, 2013, our total risk-based, Tier 1 risk based and leverage capital ratios were 18.80%, 17.54% and 10.69%, respectively, as compared to total risk-based, Tier 1 risk based and leverage capital ratios of 18.99%, 17.73% and 10.31% as of March 31, 2012. We believe by all measurements our capital ratios remain well above regulatory requirements to be considered “well capitalized” by the regulators.

Interest Rate Risk. Interest rate risk results when the maturity or re-pricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage or hedge interest rate risk.

Our subsidiary bank has an asset liability management committee that monitors interest rate risk and compliance with investment policies. The subsidiary bank utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next twelve months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the next twelve months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the re-pricing and maturity characteristics of the existing and projected balance sheet.

As of March 31, 2013, the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 0.92% and 1.84%, respectively, relative to the base case over the next twelve months, while decreases in interest rates of 50 basis points would result in a negative variance in net interest income of 2.76% relative to the base case over the next twelve months. The likelihood of a decrease in interest rates beyond 50 basis points as of March 31, 2013 is considered remote given current interest rate levels. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

Should we be unable to maintain a reasonable balance of maturities and re-pricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committee oversees and monitors this risk.

 

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Liquidity

Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument. Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary banks. Other sources of funds include our ability to borrow from short-term sources, such as purchasing federal funds from correspondent banks and sales of securities under agreements to repurchase, which amounted to $263.3 million at March 31, 2013, and an unfunded $25.0 million line of credit established with The Frost Bank which matures on June 30, 2013 (see next paragraph). Our bank also has federal funds purchased lines of credit with two non-affiliated banks totaling $80.0 million. No balance was outstanding on these federal funds purchased lines of credit at March 31, 2013. Our subsidiary bank has available lines of credit with the Federal Home Loan Bank of Dallas totaling $424.7 million secured by portions of their loan portfolios and certain investment securities. At March 31, 2013, $68.6 million in letters of credit issued by the Federal Home Loan Bank of Dallas were outstanding under these lines of credit, and there were no amounts outstanding in short-term borrowings under these lines. The letters of credit were pledged as collateral for public funds held by our bank.

The Company renewed its loan agreement, effective June 30, 2011, with Frost Bank. Under the loan agreement, as renewed and amended, we are permitted to draw up to $25.0 million on a revolving line of credit. Prior to June 30, 2013, interest is paid quarterly at Wall Street Journal Prime, and the line of credit matures June 30, 2013. If a balance exists at June 30, 2013, the principal balance converts to a term facility payable quarterly over five years and interest is paid quarterly at our election at Wall Street Journal Prime plus 50 basis points or LIBOR plus 250 basis points. The line of credit is unsecured. Among other provisions in the credit agreement, we must satisfy certain financial covenants during the term of the loan agreement, including, without limitation, covenants that require us to maintain certain capital, tangible net worth, loan loss reserve, non-performing asset and cash flow coverage ratio. In addition, the credit agreement contains certain operational covenants, which among others, restricts the payment of dividends above 55% of consolidated net income, limits the incurrence of debt (excluding any amounts acquired in an acquisition) and prohibits the disposal of assets except in the ordinary course of business. Since 1995, we have historically declared dividends as a percentage of our consolidated net income in a range of 37% (low) in 1995 to 53% (high) in 2003 and 2006. Management believes the Company was in compliance with the financial and operational covenants at March 31, 2013. There was no outstanding balance under the line of credit as of March 31, 2013, or December 31, 2012.

In addition, we anticipate that future acquisition of financial institutions, expansion of branch locations or offering of new products could also place a demand on our cash resources. Available cash and interest-bearing deposits in banks which totaled $69.9 million at March 31, 2013, investment securities which totaled $12.5 million which matures over 10 to 17 years, available dividends from our subsidiaries which totaled $43.6 million at March 31, 2013, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Existing cash resources at our subsidiary bank may also be used as a source of funding for these potential acquisitions or expansions.

Given the strong core deposit base, relatively low loan to deposit ratios maintained at our subsidiary bank, available lines of credit, and dividend capacity of our subsidiary bank, we consider our current liquidity position to be adequate to meet our short- and long-term liquidity needs.

 

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Off-Balance Sheet Arrangements. We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit, commitments to extend credit and Federal funds sold and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets.

Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.

Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income-producing commercial properties.

Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount.

Table 10 – Commitments as of March 31, 2013 (in thousands):

 

     Total Notional
Amounts
Committed
 

Unfunded lines of credit

   $ 375,202   

Unfunded commitments to extend credit

     106,700   

Standby letters of credit

     20,175   
  

 

 

 

Total commercial commitments

   $ 502,077   
  

 

 

 

We believe we have no other off-balance sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements.

Parent Company Funding. Our ability to fund various operating expenses, dividends to shareholders, and cash acquisitions is generally dependent on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiaries. These funds historically have been produced by dividends from our subsidiaries and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiaries. At March 31, 2013, approximately $43.6 million was available for the payment of intercompany dividends by our subsidiaries without the prior approval of regulatory agencies. Our subsidiaries paid aggregate dividends of $15.4 million and $13.9 million for the three month periods ended March 31, 2013 and 2012, respectively.

 

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Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of between 40% and 55% of net earnings while maintaining adequate capital to support growth. The cash dividend payout ratios have amounted to 42.4% and 42.5% of net earnings, respectively, for the first three months of 2013 and the same period in 2012. Given our current capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy.

Our bank subsidiary is required by federal law to obtain the prior approval of the Office of the Comptroller of the Currency (the “OCC”), to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank’s net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, our bank may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation).

To pay dividends, we and our subsidiaries must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that our subsidiary under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the subsidiary, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve, the FDIC and the OCC have each indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Management considers interest rate risk to be a significant market risk for the Company. See “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources—Interest Rate Risk” for disclosure regarding this market risk.

Item 4. Controls and Procedures

As of March 31, 2013, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints; additionally, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may

 

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become inadequate due to changes in conditions; also the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures, as defined under Rule 13a-15 of the Securities Exchange Act of 1934, are effective at the reasonable assurance level as of March 31, 2013.

There were no significant changes in our internal controls over financial reporting or other factors during the first quarter of 2013 that have materially affected, or are reasonably likely to materially affect, these internal controls.

 

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Table of Contents

PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time we and our subsidiary banks are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiary banks or our other direct and indirect subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities.

 

Item 1A. Risk Factors

There has been no material change in the risk factors previously disclosed under Item 1A. of the Company’s 2012 Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3. Defaults Upon Senior Securities

Not Applicable

 

Item 4. Mine Safety Disclosures

Not Applicable

 

Item 5. Other Information

None

 

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Table of Contents
Item 6. Exhibits

The following exhibits are filed as part of this report:

 

  3.1      Amended and Restated Certificate of Formation (incorporated by reference from Exhibit 3.1 of the Registrant’s Form 8-K filed April 25, 2012).
  3.2      Amended and Restated Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 of the Registrant’s Form 8-K filed January 24, 2012).
  4.1      Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant’s Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994).
10.1      Executive Recognition Agreement (incorporated by reference from Exhibit 10.1 of the Registrant’s Form 8-K Report filed June 29, 2012).
10.2      2002 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.3 of the Registrant’s Form 10-Q filed May 4, 2010).
10.3      2012 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant’s Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 filed March 1, 2012).
10.4      Loan agreement dated December 31, 2004, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.4 of the Registrant’s Form 10-Q filed May 4, 2010).
10.5      First Amendment to Loan Agreement, dated December 28, 2005, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.5 of the Registrant’s Form 10-Q Quarterly Report filed August 2, 2011).
10.6      Second Amendment to Loan Agreement, dated December 31, 2006, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.6 of the Registrant’s Form 10-Q Quarterly Report filed October 31, 2012).
10.7      Third Amendment to Loan Agreement, dated December 31, 2007, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.4 of the Registrant’s Form 8-K filed January 2, 2008).
10.8      Fourth Amendment to Loan Agreement, dated July 24, 2008, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.10 of the Registrant’s Form 10-Q Quarterly Report filed July 25, 2008).
10.9      Fifth Amendment to Loan Agreement, dated December 19, 2008, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.6 of the Registrant’s Form 8-K filed December 23, 2008).
10.10      Sixth Amendment to Loan Agreement, dated June 16, 2009, signed June 30, 2009, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.7 of the Registrant’s Form 8-K filed on July 1, 2009).
10.11      Seventh Amendment to Loan Agreement, dated December 30, 2009, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10.8 of the Registrant’s Form 8-K filed December 31, 2009).
10.12      Eighth Amendment to Loan Agreement, dated June 30, 2011, between First Financial Bankshares, Inc. and The Frost National Bank (incorporated by reference from Exhibit 10-9 of the Registrant’s Form 8-K filed June 30, 2011).
31.1      Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
31.2      Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc.*
32.1      Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc.*
32.2      Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc.*

 

* Filed herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    FIRST FINANCIAL BANKSHARES, INC.
Date: April 26, 2013     By:  

/s/ F. Scott Dueser

      F. Scott Dueser
      President and Chief Executive Officer
Date: April 26, 2013     By:  

/s/ J. Bruce Hildebrand

      J. Bruce Hildebrand
      Executive Vice President and
      Chief Financial Officer

 

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